5. External effects & public goods GENERAL ECONOMICS 5 Copyright Mark Van Couwenberghe, 2017-2018

5.0 OVERVIEW G 5 / 2 5.1 EXTERNAL EFFECTS page G 5 / 3 5.2 PUBLIC GOODS page G 5 / 13 5.3 EXERCISES page G 5 / 17 5.4 VOCABULARY page G 5 / 22 Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 3 5.1 EXTERNAL EFFECTS The production of products and services may have an impact on third parties not involved in the production = external effects These effects may be negative: Decreasing wealth Example: nuclear energy production >>> long-term impact on environment (negative effects of nuclear waste) These effects may be positive: Increasing wealth Example: education >>> long-term impact on society (positive effects on employment and society as a whole) Think of other examples: Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 4 Production of products and services generates costs We call these: internal costs (private costs) Costs generated by negative external effects = external costs Benefits generated by positive external effects = external benefits The concept of “social costs” takes into account both internal and external costs/benefits: SOCIAL COSTS = INTERNAL/PRIVATE COSTS + EXTERNAL COSTS SOCIAL COSTS = INTERNAL/PRIVATE COSTS - EXTERNAL BENEFITS Let us assume that the production of aluminium creates negative external effects, how would the supply and demand model look like? Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 5 Comments: Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 6 Draw a supply and demand model for the market of beehives Comments: Copyright Mark Van Couwenberghe, 2017-2018

government will take measures The price mechanism on the competitive market fails because the market equilibrium does not take into account external costs/benefits government will take measures to “correct” the market price (to “internalize” the external costs/benefits) Quota Examples of products/services + their external effects: Taxes Examples of products/services + their external effects: Subsidies Examples of products/services + their external effects: Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 8 Beside these “quantitative measures”, other measures are: Standards/restrictions Examples of products/services + external effects: Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 9 Economist COASE suggested that negative external effects should be dealt with WITHOUT government intervention Coase theorem states that when property rights are involved, parties naturally gravitate toward the most efficient and mutually beneficial outcome, and this trhough negotiation. The Coase theorem states that where there is a conflict of property rights, the involved parties can bargain or negotiate terms that are more beneficial to both parties than the outcome of any assigned property rights. The theorem also asserts that in order for this to occur, bargaining must be costless; if there are costs associated with bargaining, such as those relating to meetings or enforcement, it affects the outcome. Let us take the case of a family owning a house and a piece of land outside the city. A foreign company built a wind turbine near the property. The wind turbine causes (negative) external effects. Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 10 Comments: Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 11 An international way to deal with the negative external “greenhouse effect” is the so-called “Kyoto Protocol” The Kyoto Protocol is an international treaty which extends the 1992 United Nations Framework Convention on Climate Change (UNFCCC) that commits State Parties to reduce greenhouse gas emissions, based on the scientific consensus that (a) global warming is occurring and (b) it is extremely likely that human-made CO2 emissions have predominantly caused it. Under Kyoto, industrialized nations pledged to cut their yearly emissions of carbon, as measured in six greenhouse gases, by varying amounts, averaging 5.2%, by 2020 as compared to 1990. That equates to a 29% cut in the values that would have otherwise occurred. Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 12 Parties with commitments under the Kyoto Protocol have accepted targets for limiting or reducing emissions. Emissions trading, as set out in Article 17 of the Kyoto Protocol, allows countries that have emission units to spare - emissions permitted them but not "used" - to sell this excess capacity to countries that are over their targets. Thus, a new commodity was created in the form of emission reductions or removals. Since carbon dioxide is the principal greenhouse gas, people speak simply of trading in carbon. Carbon is now tracked and traded like any other commodity. This is known as the "carbon market." Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 13 5.2 PUBLIC GOODS Most products and services traded on the markets are PRIVATE GOODS; these have 2 characteristics: Rivalrous: the consumption of a specific good by a specific person will block another person to buy that same good Excludable: access to the good is only possible if the buyer pays the market price 3 other types of goods occur in daily economic life, but are not traded on the markets: PUBLIC GOODS COMMON GOODS CLUB GOODS Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 14 Characteristic PUBLIC GOODS COMMON GOODS CLUB GOODS Rivalrous Y/N + explanation Excludable Examples Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 15 Why do mostly governments offer “public goods”? Why is the production of public goods “privatized” in some cases? + find examples of privatization + analyze consequences: was it a successful operation? Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 16 What is the concept of “freeriders”? Comments: Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 17 5.3 EXERCISES 1) Factory ABC INDUSTRIES is located near a residential area. 1.000 families live in this area. As a result of the air pollution created by the company, each family experiences a negative external effect (laundry gets dirty). This costs € 150 per year per family. There are different solutions: - ABC may install a filter installation: cost = € 100.000 - each family gets a tumble dryer: cost = € 130 per family What would be the most efficient way to deal with the negative external effects? Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 18 2) This is the demand curve on a specific market: Q d = - P + 185 And this is the supply curve: Q s = 2 . P - 100 a. Calculate the market equilibium The product causes negative external effects and the government decides to set a tax of €30 per unit b. Calculate the new supply curve c. Calculate the new market equilibrium d. Calculate the % of tne tax paid by the consumer e. Calculate the total tax revenue for the government Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 19 Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 20 3) Think of 3 reasons why governments provide good traffic infrastructure 4) Take a close look at the following examples of products and services: what types of goods are these? Electricity Police Cinema Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 21 Highway Food Sports club 5) Analyze how the company that produces MARLBORO has been dealing with the negative external effects of cigarettes over the past years: Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 22 5.4 VOCABULARY EN NL Copyright Mark Van Couwenberghe, 2017-2018

G 5 / 23 EN NL Copyright Mark Van Couwenberghe, 2017-2018